Thursday, June 28, 2018

Housing: Part 308 - Why is inventory so low?

One facet of the housing market that gets a lot of attention is the very low level of inventory, especially in low-tier markets.  It looks like a strange market.  Prices seem high on a price-to-income basis, and they continue to rise.  Low inventory tends to correlate with a seller's market, and it is frequently treated as a sort of causal element.  Prices will rise because inventories are low.  I don't find that sort of framing very helpful.  But, the mysteries about the current housing market go beyond that.  If inventories are low and prices are high, why aren't buyers just moving into new stock?  Why aren't homebuilders filling this market?

Timothy Taylor has some comments on this today, here.  He covers some of these issues.  He references a study that mentions rising costs, limited lot supply, builder caution coming out of the crisis, etc.  I think all of these are false flags.  They appear to be important issues, but until a full reconsideration of the housing boom and the crisis is undertaken, it would be impossible to solve the mystery of low inventory.  The truth is that, relative to high tier home prices, low tier prices are very low.  And, taking into account very low long term real interest rates, prices are also low.  There are many regulatory barriers to new lot development, so it appears that this is the constraint.  It is a constraint, but it's not binding.  On the margin, builders are being outbid for land because the use of the land that they are trying to develop is underpriced by 20-40%.  Is there any doubt that lots would be widely available if home prices were 40% higher and builders could double their bids for lots?

But, if inventory is so low, then why don't prices rise until that happens?

The reason is that we have imposed a regime shift in regulatory barriers to home ownership, and probably more than a third of households live in homes that they would not currently qualify for.  We have created non-price barriers to ration housing through mortgage regulation, so now about half the country are housing have-nots, who must rent.  Renting comes with higher costs for management, vacancy, tenant conflicts, etc.  So, supply for rented units tends to be lower, rents relative to unit value tend to be higher, and so the quantity demanded by renters is lower than it is by owners.  This is only made worse by income tax benefits targeted at owners.

But, there are millions of households who are have-nots in the current regime who were haves in the previous regime, and they still live in homes that they own.  Given the current regulatory regime, they are over-consuming housing.  They are living in homes that are more valuable than the homes they would be allowed to live in today if they were starting out fresh.  This is one basic way to think about it.  Inventory is low because there are millions of homeowners who are sucking up more housing supply that the FHFA and the CFPB would let them if they could.  Households who were foreclosed on have reduced their housing consumption, but households that managed to maintain ownership are grandfathered in to previous levels of housing consumption.  If the current regime remains in place, then real housing consumption will be lower, rents will be higher on existing properties, and prices will be relatively lower.  In this regime, we don't need to build that many more homes.  But, in the meantime, these households are grandfathered in, and the process of shifting down real consumption of housing will be very slow.  So they have a temporary claim on a portion of the housing stock that will slowly be cured by reduced housing consumption rather than by new building.  While this transition takes place, there is less housing left for other households to claim, but no means or incentive to build new housing to make up for it because it is a temporary disequilibrium.

Thinking of their homes as financial securities, the grandfathered owners are earning very high yields on their investments based on current market values.  Partly that is because rents have generally risen after a decade of crimped supply.  But, mostly, it is because the new regime pulled prices down.  These are sunk costs.  The existing owners didn't benefit from it.  The high yield comes from their unrealized capital losses.  But, the oddity here is that the reason the prices of their homes is low is because owner-occupier demand is being arbitrarily constrained by mortgage regulators.  The reason their homes are underpriced is because buyers are being held out of the market - including them!

The great and comprehensive annual report from the Joint Center for Housing Studies of Harvard University, cited by Taylor, notes that length of tenure has risen for both owners and renters. American Housing Survey data I have seen also shows this, and the AHS data shows length of tenure that is flat until the crisis, then climbs. The reason is that households are stuck in their homes. They are grandfathered in. And, the reason that length of tenure for renters has also increased is that people who intend to remain in a unit for many years generally should be owners, but the current regime locks them out of ownership.  So, the marginal households that have become renters over the past decade are naturally stable households with longer tenures.

So, let's walk through what the market looks like for a grandfathered owner.  If they want to downsize, they probably can do that, because they would be reducing their expenses, and they might even be able to swing a mortgage, since any home equity they have would go farther toward a smaller home.  But, higher regulatory costs and limits on fees have made small loans very difficult for lenders to make.  If they want to upgrade, they are unlikely to qualify.  A home in 2002 that sold for $140,000 might have rented for $1,000 and had a monthly mortgage payment of $750.  That family would still have a monthly payment of $750 (or slightly more or less if they refinanced along the way), but now rent would be more like $1,300.  So, a move to a similar property would entail an increase in their monthly cash outflow from $750 to $1,300, and it would only get worse if they tried to trade up to a better unit.

Homeowners get a tremendous deal today because home prices are being held down by repressed lending.  Moving out of a home that is owned to a rental unit is a terrible deal, right out of the gate.  The same factor that prevents this household from moving into another owned property is the reason that the deal they have for remaining in the property they own is so great.  No marginal shift in price is going to overcome that.  The only way to break this logjam is for prices to rise significantly, and the only way that will happen is for mortgage markets to loosen up significantly.

This is why "low inventories will lead to rising prices" is not a useful framing.  If prices rise, it will almost certainly be associated with rising inventories.  And, if the public understanding of the housing market remains mired in its current form, that will be accompanied by dire calls for economic contraction, because rising prices in the face of rising inventories will look like a market top that is leading to oversupply.  Intentional contraction will lead to....well, contraction....and the contraction will be blamed on loose lending and oversupply.

If your model for managing the macro economy calls for contraction, then model error and model confirmation both look exactly the same.  That is the problem with models from the Minsky school or the Austrian business cycle.  If their calls for cutting the boom off at its knees are wrong, they actually create unnecessary instability, and that only leads to calls for doubling the dose of poison.  That sort of conclusion infects much of the thinking about the housing boom and bust.  As long as Fed policy is viewed as a function of interest rates, it will be an infection that is difficult to cure.  We can see how difficult it is to cure, since low tier markets tied up in knots with very little activity or building don't seem to have dampened the idea that loose money is the cause of high prices.


  1. Another great post.

    A quibble.

    As Kevin Erdmann has so thoughtfully delineated, there are two Americas, that of the closed-access cities and the rest.
    (I am simplifying).

    "Is there any doubt that lots would be widely available if home prices were 40% higher and builders could double their bids for lots?--Erdmann.

    Yes, I have doubts any more lots would be available in Los Angeles, and probably most other West Coast cities, or NYC etc.

    So much of those cities are already maxed out at current zoning. Only developers who are able to bribe, or finagle government into zoning changes or building variances can get anything built. Then the NIMBY factor comes in. Many neighbors (renters in particular, but also homeowners) do not profit no matter how high a particular lot sells for, so they are against development.

    Prices have zoomed on the West Coast, and development has hardly budged (although downtown L.A. is staging a force-fed comeback. It is nearly the only place in L.A. where a residential tower can be built).

    So, yes, end financial repression of wanna-be homebuyers, I am all for that.

    The killer is property zoning or other building constraints (often zoning in drag).

    Side note: After 2008, there was hue and cry from certain financial elites that they were suffering from "financial repression." Artificially low interest rates.

    So who was financially repressed at the ground level? Wanna-be homebuyers.

    But they did not have the megaphones.

    1. Sorry. I should have been more clear. Regarding lot availability, I am referring to the lack of building in entry level affordable markets. Not Closed Access cities where there is definitely a lack of lot availability.

  2. Monetary tightening will never ever solve a supply constraint. It's not intended to. But we have an inflation any given time there will be (unfortunate) supply constraints in a variety of products. Looking at such products in isolation you will always conclude "the Fed should ignore that because a tightening wont't fix the supply constraint." And yet, in aggregate we need to keep nominal growth in line with overall growth in supply of homes/goods/services. If we were to remove the supply constraints to housing supply, then the Fed could react accordingly and stimulate. Any other way of approaching the situation is simply a recipe for permanently above-target inflation.

    Also odd, is those who like to point out "temporary" supply constraints don't like to point out "temporary" supply boost. It's very possible shale oil is a temporary boost to energy that logic the Fed should ignore the low price of oil and tighten ahead of schedule. Correct?

    The ball is in the hands of government to fix supply constraints. The Fed needs to maintain aggregate price stability regardless of whether regulators do their job.

    1. Owner-occupier rent is different than other prices. To be brief, the Fed is in the business of managing aggregate cash flow to productive activity. The price level of rent for owner-occupiers doesn't involve current productive activity or cash. If the BLS decided that my house suddenly has a rental value of $10 trillion a month, it would increase the measured rate of inflation, but it should have no influence on the Fed's cyclical management of aggregate cash levels.

    2. Ignoring the cost of living for 45% of the country (and a much higher percentage of the "have nots") is a very dangerous way to managed the economy. Strikes me as a great way for a central bank to lose its independence in the long-term. One common thread you hear from the various populist movements around the world is that rent is too high.

    3. Somewhere on the west side of San Francisco, there's a little old lady who bought her house for $50,000 in 1980, paid the mortgage off in 1995, and continues to live there. According to the BLS, she's spending $5,000 a month on rent, and it is probably rising by 5% or more annually. That happens enough that it has a significant effect on measured inflation. It is not useful for the Federal Reserve to manage the money supply to lower her "nominal" rent level. I'm not talking about people who pay for their rent in cash.

    4. My daughter and I were thinking that there is no way the millennials will ever be able to buy up Del Webb when it comes to their turn to be old.